GameStop's Digital Strategy Boosted by Acquisitions

April 04, 2011

US games retailer GameStop has acquired Impulse, a digital PC games distribution platform, and games streaming technology specialist Spawn Labs. Financial terms were not disclosed: management characterised the price for both combined as similar to the sum Gamestop paid for Kongregate in 2010, which was also not disclosed. IHS Screen Digest believes GameStop paid a price in the low tens of millions of dollars for Kongregate.

AnalysisGameStop is moving aggressively to optimise its strategic positioning as the industry moves from a packaged retail model, which comprises the vast majority of GameStop's business, to a variety of digital and online service oriented opportunities. GameStop earmarked a warchest of around $100m for digital acquisitions in 2009 which initiated the recent spate of acquisitions. While many execution challenges lie in wait for the retailer, doing nothing is no longer a viable option for any retailer specialising in packaged entertainment media. Inaction during such a fundamental transition in how consumers discover, acquire and play games is tantamount to accepting low to negative earnings growth, negligible to zero market share in the fastest growing segments of the industry, long-term revenue contraction, reductions in the size of the retail estate and staff and possibly eventual oblivion.

GameStop seems determined to avoid such a fate and is building a portfolio of digital games capabilities to augment its retail operations in 16 international markets, led by the huge US market. GameStop sells packaged games via its website which also offers

downloadable PC games (many released at the same time as physical retail)

pre-paid cards/codes for console DLC for PSN and Xbox Live

virtual currency pre-paid cards for PSN, Nintendo WFC, XBL and a host of PC online games including games on Facebook (GameStop believes it currently enjoys 35 per cent market share of pre-paid virtual currency cards in North America)

freemium flash games through Kongregate, the flash games portal which it acquired in 2010, and Jolt Online which it acquired in 2009

freemium social games on Facebook produced by Jolt

Kongregate Arcade, games for Android enabled mobile devices

IHS Screen Digest expects GameStop to integrate Spawn Labs and Impulse into its existing suite of online services, which is becoming increasingly varied and sophisticated.

Spawning Competition in Video-Streamed Games-on-Demand ("VSGoD"): GameStop Enters the CloudSpawn Labs has developed technology which enables gamers to stream games they own over the public Internet in order to play them remotely (sometimes referred to as "spaceshifting"), analogous to Sling Media's streaming technology for music and video. The games are served and hosted by the gamer's consoles or PC, are played remotely on a laptop or PC and changes in the game state are relayed back to the consoles following remote play.

GameStop intends to target 8m members of loyalty card scheme PowerUp with the ability to play their games libraries remotely however it did not reveal details about how it intends to monetise the service. It demonstrated the capability with Xbox 360 exclusive title Halo Reach played remotely on a laptop which immediately raises questions as to whether the console manufacturers are content for GameStop to pursue such an initiative, or whether it is even legal across major games markets. National legal frameworks regarding streaming of owned media have yet to be tested to the extent that both this initiative and Time Warner's streaming of cable channels to tablets are likely to.

A host of detail regarding the implementation has yet to be shared by GameStop which would allow more in-depth evaluation of the service's potential. Given the service is targeting existing games libraries and the gameplay is hosted on an individual's consoles the argument for cutting consumer hardware costs does not apply as it does for other VSGoD operators Gaikai and OnLive. The question of loosening the traditionally high levels of control console manufacturers like to exert over their platforms also looms ominously.

GameStop also demonstrated using Spawn's technology to stream a demo of a console exclusive game, recently released PS3 title LittleBigPlanet 2, from its website. The benefits of using VSGoD to stream a demo are significant:

to play the demo on PS3 the customer must of course have access to a PS3 connected to the Internet, must log into PSN and navigate to the PS Store and download a 2GB demo which even on fast broadband connections is likely to take in excess of 90 minutes

a customer at GameStop's webpage for purchasing the physical retail version of LittleBigPlanet 2 may have his urge to trial the game satisfied in less than half a minute through Spawn's streaming technology, an instantaneous experience which is likely to capitalise more effectively on a customer's interest in a game compared with the relatively onerous experience of remembering to initiate a multi-gigabyte download when one is next using their home console

having trialled the game, the GameStop customer may choose between a preowned or new version of the game from the same page which launches the demo. Fulfilment by online console stores depends on there being a digital version of the game available which is often not the case. None of the online console stores offer physical retail versions of games and obviously do not offer preowned versions

for games publishers, streaming demos costs significantly less than distributing multi-gigabyte downloads for demo purposes

GameStop did not indicate it was considering using VSGoD technology to drive games sales in a similar way to either Gaikai or OnLive - indeed the datacentre and network capacity demands of serving streaming gameplay at scale woudl significantly increase the investment required compared with the two applications GameStop has announced (of which only demo serving requires it to host and serve the stream). Screen Digest believes the video-streamed games-on-demand opportunity will grow to around $360m in 2014 in North America and Western Europe however we will be reviewing our forecasts in the light of this announcement.

Impulse Acquisition Raises Ante in PC DTO SectorIntegrating Impulse into GameStop's e-commerce operations will enable it to end the partnership with its existing third party technology provider Real Networks. Offering a proprietary service is likely to enhance GameStop's profit margins on downloadable PC games. It will also add a significant amount of functionality to the existing offering with a range of community tools giving consumers more reasons to stay on GameStop's website.

Acquiring Impulse enables GameStop to intensify competition with established PC download-to-own ("DTO") specialists Steam, Direct to Drive and others. IHS Screen Digest believes that Impulse accounted for around 10 per cent of the PC DTO market with Steam by far the dominant operator with over 60 per cent of the global market. Impulse offers electronic retail distribution technology including DRM, payment processing, account management, a variety of community building tools (friends lists, achievements tracking, voice chat) and a library of over 1100 games.

IHS Screen Digest is in the final stages of sizing and forecasting the global market for PC DTO consumer spending and will add the model to the Games Intelligence service shortly. GameStop's management peg the North American PC DTO market size in 2011 at $700m.

GameStop's Transition Augmented by Legacy BusinessesWhile the emerging digital and online gaming sectors provide significant growth opportunities, competition is intense and many require significant and sustained investment before profitability is achieved. GameStop however possesses some key advantages from the physical retail business, not least a very high level of brand awareness amongst gamers built over many years. GameStop's PowerUp loyalty card scheme is also likely to play a key role in driving growth in its new initiatives: access to over 8m customers in North America alone is a huge advantage over start-ups with limited resources for large scale marketing campaigns.

GameStop's enormous preowned business is also a significant differentiator and the company is working on ways of leveraging the billions of dollars of credit for preowned games trade-ins generated annually. On top of driving significant levels of spending at physical retail (GameStop estimate that 17 per cent of consumer spending across its business is from trade-in credit), GameStop allows customers to use trade credit for DLC and for virtual currency. GameStop confirmed that 23 per cent of Black Ops First Strike DLC sales for Xbox 360 were purchased with trade credit - this was a not insignificant volume either given Black Ops was the top selling title in 2010 and GameStop generated a 28 per cent DLC attach rate to retail disc sales.

Around 3 per cent of GameStop's fiscal 2010 revenues of $9.5 billion were generated by digital and online games: $285m. Obviously the scale is some way from matching GameStop's mature legacy business and is unlikely to do so for some years. But given the physical retail business grew at just under 5 per cent in the fiscal year while digital grew by 65 per cent it is clear where GameStop's growth engine lies. Management is targeting 50 per cent revenue growth year on year for the digital portfolio and is assuming wider digital games market growth of 15 per cent per annum. As other dedicated games retailers even with market leading positions in key territories have found, investors are quick to punish entertainment retailers without a viable digital strategy. Recent history is littered with a growing pile of entertainment retail corpses - Tower Records, Borders, MVC, Woolworths, Zavvi, Blockbusters - and GameStop is clearly determined not to join them.

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